CHAPTER 10: PURE MONOPOLY
Introduction
While the perfectly competitive firm has no power over prices in the marketplace, the monopoly
has the power necessary to determine both the price and output of the product. The monopoly
model shows us important differences from perfect competition in terms of efficiency and effects
on producer and consumer surplus. Chapter 10 focuses on the ways monopolies develop, output
and price determination, the effects of monopoly behavior, and government regulation. The
monopoly model is important to understanding the oligopoly and monopolistic competition,
which will be covered in Chapter 11. Material from Chapter 10 appears on the AP
microeconomics exam in a large number of multiple-choice questions, and a free-response
question about decision making in at least one of the market structures is part of nearly every AP
microeconomics exam.
Pure Monopoly
A pure monopoly is a market structure with only one producer, no close substitutes, and complete
barriers to entry. Unlike a price-taking perfectly competitive firm, the pure monopoly is a price
maker, with the firm determining its own output and the price it will charge for its product.
Because the monopoly faces a downward-sloping demand curve, it can restrict output in order to
raise the product price. Pure monopolies include local natural gas, electricity, and water
companies, as well as pharmaceutical companies that hold patents on particular medications.
Near monopolies also exist where a single firm provides the vast majority of sales in a particular
industry.
Barriers to Entry
Monopolies hold market power, the power to determine prices, because of barriers to entry-
factors that prevent competitors from entering the industry. While perfectly competitive firms
face no barriers and are free to enter and exit the industry, imperfectly competitive firms must
deal with barriers. Monopolies, for a variety of reasons, are able to completely prevent potential
competitors from entering the industry.
$20
til
8 15
1i
S
"~ 10
~
o 50 100 200
Quantity
Economies of scale
One important barrier to entry is economies of scale. The larger the firm's output, the more
efficient the firm becomes. Natural monopolies achieve economies of scale, with their average
total cost curves continuing to fall over a very large range of output. In this example, if one firm
produced 200 products, the average total cost would be $10. But if two firms each produced 100
86 Chapter 10: Pure Monopoly
units, the average total cost would be $15; four firms each producing 50 units would lead to an
average total cost of $20. Clearly, it is more cost-effective to have one large producer. These
economies of scale also serve as a barrier to entry for new firms, which face those higher costs as
smaller producers.
The government also creates barriers to entry by granting patents and licenses. The government
grants a patent, which protects an inventor's ownership rights, in order to encourage investment
in research and development. For the life of the patent, the owner has monopoly control of the
product and can use revenues to recoup research and development costs and potentially to support
further development of other products. The government can also create a barrier to entry by
licensing producers, from taxi drivers and cosmetologists to teachers and electricians.
Other firms create barriers to entry by controlling the resources necessary to produce the product.
Monopolists deeply cut their prices to undercut the competition, make deals with retailers to
reinforce their monopoly status, or find other ways to make the competitor's product more
expensive or less desirable.
Monopoly Demand
Analysis of the pure monopoly assumes no firms can enter the industry, the government does not
regulate the firm, and the firm charges the same price for every product. The most important
difference between the perfectly competitive firm and the pure monopoly is the demand curve.
Remember, the perfectly competitive firm was a price-taker, accepting the price set in the
industry. So the individual firm had a perfectly elastic, horizontal demand curve, with the
marginal revenue equal to the product price.
Because it is the only firm in the industry, a monopoly has only one graph, unlike the side-by-side
graphs for perfect competition. Also, a monopoly faces a different demand curve. Because it is
the only producer, industry demand is the firm's demand. Therefore, a monopoly faces a
downward-sloping demand curve, with quantity demanded increasing as price falls. This
difference has important ramifications for price and output decisions.
First, the marginal revenue curve is lower than the price curve. For the firm to sell more
products, it must lower the price for all the goods it sells, not just the last one. Therefore, the
marginal revenue-the change in total revenue from selling one more product-will be lower